The case for real estate as investment

The authors of the aforementioned study — Òscar Jordà, Moritz Schularick and Alan M. Taylor — have constructed a new database for the U.S. and 15 other advanced economies, ranging from 1870 through the present. Their striking finding is that housing returns are about equal to equity returns, and furthermore housing as an investment is significantly less risky than equities.

In their full sample, equities average a 6.7 percent return per annum, and housing 6.9 percent. For the U.S. alone, equities return 8.5 percent and housing 6.1 percent, the latter figure being lower but still quite respectable. The standard deviation of housing returns, one measure of risk, is less than half of that for equities, whether for the cross-country data or for the U.S. alone. Another measure of risk, the covariance of housing returns with private consumption levels, also shows real estate to be a safer investment than equities, again on average.

One obvious implication is that many people should consider investing more in housing. The authors show that the transaction costs of dealing in real estate probably do not erase the gains to be made from investing in real estate, at least for the typical homebuyer.

Furthermore, due to globalization, returns on equities are increasingly correlated across countries, which makes diversification harder to achieve. That is less true with real estate markets, which depend more on local conditions.

Ray Lopez

@anon - thanks for the links. As for your last two sentences, if US stocks survived WWI, WWII and the rise of Big Govt I don't see why, short of a nuclear catastrophe, which could happen, they don't survive the next 100 years, probably with subdued "Japan style" growth.

anonymous

mkt42

Yeah, I've put some of my savings into a mutual fund that invests in real estate as a sort of financial substitute for buying a house. (I live in an apartment because I don't want to own a house; owning a condo or townhouse could be okay but then I'm subject to the whims of the owners' association; with an apartment it's easier to walk away if necessary and I don't have to worry about maintenance because somebody else is doing it).

Two additional comments about housing-as-investment though: the book _Houseonomics_ talked about this some years ago (ironically it was published just after real estate prices peaked in 2007).
https://www.amazon.com/Houseonomics-Owning-Still-Great-Investment/dp/0137133782/

And I'm still keeping in mind what Martin Feldstein has been saying for decades: US policies especially its tax policy about the deductibility of mortgage interest payments encourage Americans to over-invest in housing. As a country we'd probably be better off if we built less housing and put that capital to better use.

msgkings

Hmmm

The US needs less capital and investment in single family homes, which is driven by zoning regulation artificially acting as a price floor, and more capital and investment in apartments and condominiums.

clockwork_prior

'Prior to the well-publicized burst of the housing bubble and the resulting real estate crash that began in earnest in 2007, historical housing price data from the National Association of Realtors (NAR) seemed to support the theory of endlessly rising prices. The chart below tracks median home prices from 1968 to 2004 and shows an average yearly increase of 6.4%, without a single decline during the 36-year period.

Unfortunately for homeowners, 2004 was the last year of healthy growth numbers before the market flattened. By 2006, NAR data showed just a 1% increase. After that, the markets experienced an unprecedented decline.

Nationally, prices fell in 2007. They fell again in 2008 and yet again in 2009. By mid-2010, housing prices had fallen back to 2004 levels in a stagnant market. What had for decades seemed like a one-way ticket to growing profits had fallen by more than 30% in just a few years, according to Standard & Poor's data.
-------------------------

With the size of homes getting bigger and inflation adding to the cost of building materials, it is only logical that home prices would rise. But what happens if inflation is factored out of the picture? The result is something completely unexpected. Even before the real estate crash of the late 2000s, home prices fell frequently and significantly.

In fact, World War I, the Great Depression, World War II, the 1970s and the 1980s, all saw periods of significant price decline. Lesser declines have occurred on a regular basis at other points as well.'

Anonymous

Bingo. Appreciation can actually screw up a real estate investment to some extent because it reduces your leverage and therefore your future returns. Once there has been dramatic appreciation, you have a decision to make about all the equity locked up in the house. When valuing a real estate deal, I assume appreciation at the rate of inflation only and the returns are still excellent.

Ray Lopez

Since this is the dissenters post, I will add that the Washington Post in March, 2007 ran an article that found DC housing, while good, is not as impressive as some people think. Here is the capsule summary: "Not as Rich as You Think - This table shows the costs of buying and owning a hypothetical home in suburban Washington, DC. The house was bought in 1977 for $55,000 and is valued this year at $860,000. If they sell, the owners would pocket about $550,000, an apparent 10,900% return on their $5,000 down payment. But further examination of their costs—typical for a house owned for three decades—makes clear that the owners would have a nice but far more modest profit of just $175,000. Sellers elsewhere could easily end up losing money."

I myself have found landlording a chore. We're looking to scale back on our slum dwellings after building something new and flipping them. You have to deal with all kinds of people of all walks of life, most of them clueless, and it's like a hotel if you have month-to-month teardowns like we do. Cash cows however, but still you get about the same yield as you would in a diversified good stock fund. Not much capital appreciation unless you tear down and build new.

Brian

The paper said: "We find that more exotic models cannot resolve these even bigger puzzles, and we see little role for limited participation, idiosyncratic housing risk, transaction costs, or liquidity premiums."

So no mention of maintenance there, but I am glad you were not remiss on that point.

Per Kurowski

Invest in houses only if you are sure that in the de facto class war between those owning houses as investment assets and those only wanting to afford a home, the first will, thanks to all kind of subsidies awarded to the purchase of houses, keep on winning.
https://subprimeregulations.blogspot.com/2018/12/affordable-homes-or-investment-assets.html

rayward

Uhm, how many millions of Americans lost their homes in the great recession? Housing prices fell by a third and 10 million people lost their homes. Why didn't they just sell as the prices began to fall? Housing is illiquid, unlike most equities. What Cowen has done is measure the appreciation in housing over a long period without considering the volatile nature of real estate prices and the illiquidity of real estate. For someone who has a secure job over a long period of time, such short term risks may seem remote. At least 10 million people might disagree. Besides, falling real estate prices lock people in to a house and a job and don't allow people to move to areas with greater opportunity. I seem to recall a particular economist making that point more than once. So why don't Americans just pick places to live that will experience escalating real estate prices and lots of good jobs? All 400 million of them.

rayward

I've commented many times that a policy that relies on rising asset prices for prosperity is a losing policy. Indeed, what we have in the U.S. is a policy that relies on rising asset prices and high levels of consumer debt for prosperity: both promote/support a high level of consumption. What could go wrong? What we need are policies that rely less on rising asset prices and consumer debt, policies that will promote more investment in real technology, the kind of technology that will provide a high level of economic growth as the result of both gains in productivity and lots of well-paying jobs. Even Cowen's friend Peter Thiel agrees.

rayward

To restate the obvious, the current policy in America is rising asset prices. Look at how the Fed retreated when stock prices dropped in the Fall in reaction to interest rate increases. We are stuck in a policy of rising asset prices and rising consumer debt. So Cowen is right: investing in assets makes perfect sense. But it will end in another disaster. How could it not? Economists may think they can maintain this course, but they can't.

RatInPutinsMaze

+1, I think that's wisdom. Your casual middle class family already has a very large part of their assets in real estate. At that point, it makes sense for them to diversify into some other category . There are cases where a person has good knowledge and skills which might make real estate attractive. But if you're purely passively investing, then diversification seems prudent.

jack

This conclusion is highly unlikely and flies in the face of lots of capital market research, which shows that returns on property lie between returns on bonds and returns on equity. And that makes sense because property is more risky than debt and less risky than equity. There are lots of publicly traded real estate companies all over the world and their returns tend to fall between debt and equity. This sounds like a free lunch. Maybe an economist should analyze the study?

Sigmund Aas

AS most others who have commented here you really should have read the paper, or at least all of Tyler’s piece before commenting. The problem with previous research on the returns to real estate is that there hasn’t been available any long run time series on the development of rental income and the yield of properties. This has been rectified by the authors of this study and when you include rental income real estate suddenly becomes on of the best investments. To be honest I don’t understand why this comes as such a shock to most people. Even the highly flawed index constructed by R. Shiller for US housing indicates that house prices has increased slightly more than inflation, thus rents ,USF have increased slightly more than inflation and therefor investors would see a fairly stable yield over the long run.

TMC

Exactly, it's a long term proposition. I have several single fam homes bout before he run up and crash. I put my money into them at the beginning, and they pay for themselves the rest of the time. House prices dropped and came back again. Rents got a little stagnant, but no bad. Didn't notice the blip.

I just took a look at them to see if it's a good time to sell. No, can make the same return on them anywhere else. Rents go up, and payment stays the same. Amount of principal being paid each month also goes up.

greg

I can't speak for other people, but I hold more cash than I "should" so I can take more risk and have more flexibility in my professional life. Maybe that's why others do as well. Potential payoff is much larger.

Ryan

Yeah, my first thought was that people hold lots more cash because they don't have a clear view of their liquidity requirements or time horizon, and then err on the side of solvency. In plain english: I don't know when I might want to spend on something big, or when I might have an unexpected financial demand, so I'm going to hold a big buffer of cash just in case. As your wealth increases that cash buffer is probably going to account for a smaller portion of your total wealth.

And if you're young that's probably also going to make you favour cash a bit more as well (less clarity on financial goals or timing).

Hmmm

Dave

Well, it's extremely easy to gain widely diversified equity market exposure: the cost is less than 10 bps per year for plenty such mutual funds and ETF's. And, contra what clockwork_prior is apparently trying to claim, the wipeouts of shareholders in companies such as Worldcom and Enron are captured as part of total equity market returns.

TMC

Even the homeowners in Flint, Akron, and Youngstown have the choice of leaving or staying. If they stay, owning a home, in the long run, is cheap rent. If it never appreciates you're at least paying off the loan.

ChrisA

Is this returns on a leveraged basis or on an equity basis? The advantage of real estate seems to be that you can easily borrow against it, which is much more expensive to do for equities. As a result as an inflation hedge it is unrivalled - you borrow in nominal dollars but your returns are in real. So your portfolio, if you are lucky enough to have one, should always contain some real estate. But not exclusively - diversification is also important.

One interesting point on this, it seems like naive investments do the best. The more you read about investing probably the worse an investor you are. Naive investors are people who do dumb things like buy houses with loads of leverage and buy Apple because they like the Iphone, and load up on Bitcoin at $30. Of course we sophisticated investors, who read all the financial press, know these are dumb decisions......

Beliavsky

I own a home and don't want to be a landlord. There are REITs (real estate investment trusts) in the S&P 500 and other S&P indices. Is there a case for buying a REIT fund in addition to a stock index fund that owns REITs? REITs own not just housing but commercial real estate.

Clay

Personally I like housing in part because of the aforementioned “imputed rent” and partly because of the fact that, unlike the stock market, there are lots of market participants who are in it for reasons other than simply to make money - meaning less market efficiency and more ability for an opportunist like myself to find above market returns.

Vivian Darkbloom

I've not read the study and have no intention of paying $5 for reading it. But, if someone has read it, I would appreciate a short summary of how they dealt with the following:

1. Apparently, they've considered "transaction costs" which, per Cowen's summary " probably do not erase the gains to be made from investing in real estate". I'm curious as to what they include in transaction costs (in addition to the obvious buying and selling costs): on-going real estate taxes, maintenance, insurance improvements? The "probably don't erase" bit is kind of weasly to begin with. What's the sense of advising a particular type of investment without including all costs and net of tax? Isn't what I'm able to put net in my pocket the real standard?

2. Are we talking about owner-occupied real estate or purely investment real estate? The main article in Bloomberg seems to suggest the former and also seems to suggest the authors included the deemed rental value as part of the "return on investment". That might be appropriate but there are a lot of valuation issues here.

3. Are the calculated returns pre-tax and after tax?

There are a lot more questions about this study and I don't think one does the public a service by simply advising that they invest more in "real estate" without disclosing much more about the methodology, etc, or even the type of real estate we're talking about.

wiki

I'm skeptical that they fully took into account the costs and hassles of being a landlord as my short experience as one totally soured me on the idea. There's a lot of selection bias in who ends up becoming a landlord and passive returns that use a management company don't have the same returns as individual home ownership and side rentals. The paper made a lot of assumptions that need to be unpacked.

Joe User

I suspect the "housing" in the study does not include commercial real estate.

Otherwise, I see in my inbox that you can buy a property in Houston leased to corporate Jack in The Box for a return of 5.5%, with no additional ongoing costs and trivial management responsibilities (single tenant NNN). It's not clear if the structure or just the land is for sale; if the sale includes the structure, you can depreciate that cost to reduce your taxes. On top of that, when you do sell the property, you can defer paying the capital gains tax with a 1031 exchange.

There are 4.5 years left on the primary lease with 4 5-year options. If you do your due diligence to make sure that's a well-performing location, that tenant will be there for a long long time. There should be not too much cost and worry associated with tenant turnover.

RatInPutinsMaze

mpowell

Does this return assume a real estate management company or not? And when they say real estate is less volatile, do they mean for the market as as whole or looking at specific locations? When I buy an investment property, I get exactly one location in one city. If I ever want to move cities, I need to use a property manager know, eating significantly in my returns. And I have no chance to realize the total market return of, say, an equity index fund. I am exposed to the idiosyncratic risk of that specific region and even that single home in the case of one purchase. At best I can invest in a handful of homes spread across a single metro area. From the paper abstract it does not sound like they are comparing the volatility of an equity index return to a single house, but isn't that the appropriate comparison?

mpowell

I'm going to respond to my own comment and add - if you haven't accounted for management cost, you haven't done it right either. The personal time management overhead for equities approaches zero. On the other hand, the management overhead for real estate ownership is huge. Owning more than 4 properties is practically a full time job.

TMC

It is also a part time job, but nothing nearly that bad. I have a quad and 4 single family houses for 8 units. Most months I don't see any of them. Average turnover is 3-4 years so I spend about 20 yes there when that happens. The singles are nice. I drive by every so often, but 2/4 I haven't been in in 2 years. The other 2 I have about an hour into for each in the past 2 years. I took me a while to get to this though.

Anonymous

I think the problem is that markets, houses and transactions vary so widely that you can easily be screwed or hit a gold mine, depending on whether you know what you are doing (and to a lesser extent, get lucky). If you just average everything out, it's not going to give you an accurate picture. You can't buy any property and get the average return.

RatInPutinsMaze

Robert Simmons

"Furthermore, due to globalization, returns on equities are increasingly correlated across countries, which makes diversification harder to achieve. That is less true with real estate markets, which depend more on local conditions"
Wait, what? The greater idiosyncratic risk of a home (which generally dominates net worth and is generally the only house someone owns) is good for diversification/risk reduction?

derek

I don't know what the tax situation in the US is regarding gains from sale of your home, but if it is your primary residence in Canada there are no capital gains taxes. So any return is at least 1/3 more than otherwise.

msgkings

Which is why for most their primary residence is all the real estate they need, and if they want to diversify they can place their other assets in stocks and bonds. Once you have enough capital you can also mix in investment property.

McMike

When you say mix in investment property. Do you mean buy a house to rent, or maybe a lot or condo to flip?

I know several people who have done well with being rental house owners, it's a nice little cash annuity and a bonus when you sell, but it means becoming a landlord, and that means a lot of time and some headaches.

And I know a lot of people who ate it BAD when the market turned, and they were stuck with vacant lots and condos they desperately wanted to get out of.

msgkings

Well sure, landlording is more work than stocks and bonds. It's not for everyone. And yes you gotta endure some very rough patches. If you don't have to desperately get out and can hang in there, you are fine. See TMC's comment above.

Like all things people take it too far. In 2005 every show on TV was about flipping houses. Some folks got caught up in buying tons of properties with little or no money down. When the downturn hits, those types are screwed. But if you own a couple properties, no more than you can handle, with some equity in them you can ride it out.

msgkings

Forgot to add, note the difference between your friends that did well being landlords and the ones that didn't trying to flip condos and vacant lots. Totally different deals and risk levels. Don't do the flipping.

McMike

Oh I agree, that's all true, I just consider landlording as almost more of a part time job than an investment, at least until you can lever up to paid management. It's simply not an option for many people as an asset class. That's why it pays comparatively, requires a lot of patent illiquid capital, and requires hands-on, on-site effort. Can't just call a broker.

Achal K

Sam Altman said this quite eloquently, so I will just paste the quote verbatim to make argument against real estate as an investment -

"I think one of the things that’s gone badly wrong in the United States is, we have now pursued for a long time a policy where we want housing to be an investment, not a consumption asset, and thus grow faster than the rate of inflation. After you let those curves compound out for many decades, you get the predictable disaster we’re in now, where you basically steal the future from young people."

Anonymous

rayward

So what's the Straussian interpretation of Cowen's post at Bloomberg. Nobody here believes the literal interpretation: it's not like Cowen is an idiot and doesn't appreciate that real estate prices are highly volatile. So, dear readers, what is it?

carlospln

Captain Slime

A lot of Boomers are headed to nursing homes in the coming years, and their houses will come on the market. Who will buy them?

Not Millennials with student loans and McJobs.

It's not surprising that asset prices go up when each generation is better off than the previous one and more populous. If that's no longer the case, then analyzing trends all the way back to 1870 is a pointless exercise

Ethan Bernard

Rob

This is true, though not for most millennials, who will not be so lucky. I know a few (yes it's anecdotal) millennials here in New York City who are inheriting a apartments from their family to earn rental income while they hold down some pretend day job either "working" at the family real estate firm or being a below par developer at a startup.

The article has me confused about whether Tyler is becoming increasingly dense or just abstruse. Maybe both?

This line, "the millennial generation, which is often house-shy due to having experienced both the real-estate bubble and high student debt, is missing out on a good investment" is particularly stupid. Millennials are not house shy due to living through a bubble or even student debt, although that is a contributing factor. The main reason that millennials do not own property (real estate or otherwise) is the massive asset inflation bubble driven by QE, while wages have remained depressed. If anything, millennials are acutely aware that they are serfs without any ownership opportunity.

Tyler's inability to understand people younger than him is understandable, but his inability to approach this as an economist is not. No analysis of how bad it would be for America if more people spent money on rent seeking behavior? At least equities help provide liquidity to those who finance actual investment by buying an IPO. A really poor showing here, Tyler, as a writer, thinker and economist. All around, maybe some of the worst of Tyler's work that I've ever read.

Augie

I cannot quite make sense of the below claim, can someone help me out?

"Furthermore, arbitrage from wealthy outside investors — who face few liquidity constraints — apparently has not been strong enough to eradicate the rate of return differentials across real estate and lower-yielding assets."

Can one arbitrage real estate? Also, we've witnessed yields in investment grade real estate in "international cities" plummet during this cycle as a result of international investors (the less liquidity-constrained high net worth individuals and open-ended institutional funds) seeking safe havens (and positive optics).

Brian

If a person in the year 1870 had this report from 2019 they would "arb" this opportunity instead of owning bonds and they would even sell bonds to finance it. Arbitrage is not really the right word here.

Dave

I take that concept to mean large (essentially institutional) sources of capital buying single-family homes in large numbers with the goal of generating returns from a mix of rental income and price appreciation.

I'm almost certain that attempting to do so on a large-scale basis is a recent phenomenon, at least in the U.S. There are now a few publicly-traded REIT's focused on single-family housing ( http://investsnips.com/list-of-publicly-traded-residential-real-estate-investment-trusts-reits/ ), but AFAIK none of them existed prior to the housing bust. The traditional view has been that single-family homes don't work well as an investible asset class for REIT's/institutions because of scale problems: it's tough to buy enough houses one-by-one to get critical mass in a market, and they're relatively expensive to manage and maintain. That's in contrast with commercial real estate and large apartment complexes, where large institutions (including REIT's) have long been active.

Cytotoxic

1) If I have money invested in mutual funds, I can move that money around. If taxes go up here, I'm moving it somewhere better. I can change my asset composition pretty much on a whim. If I have a house, I have that house where it is and that's that regardless of where property taxes go and what tenant "rights" are imposed on me, not to mention a million other tyrannies of local government.

2) I think money is the key here. IIRC, up until the USD was devalued in 2001, equities worked and property was stagnant. Real estate prices really shot up as the USD was devalued as money flowed from the 'unknown to the known'. That set up the 'boom' (which was really a stagnation) and the bust (which was really the start of the recovery).

Tom C

I expect better from the author.
First, housing prices are usually appraised, or only evaluated occasionally, when a trade takes place. That will falsely lower asset volatility. Second, owners generally spend money improving their homes, so a good part of the measured appreciation has been paid for by them. Third, taxes and upkeep matter a lot. As an example, when some creditors foreclosed in 2009, they eventually got negative recovery on the asset. That is, those creditors would have been better off giving the house back to the former owners. I'm sure no return series would show that, yet it did happen. Fourth, what your neighbors do matters a lot: housing prices in Detroit fell by about 90% in some places.

my recurring theory is that anyone who even attempts to voice a systemic critique of US foreign policy will be framed as an Other/the enemy

TC, please stick to interesting strategic, macro ideas that you can be equally prescriptive yet "straussian" (but interesting!) and vague enough to never be wrong!

Your investment advice does not address the practical questions of liquidity of real estate, what means of real estate are you referring to (renting, flipping, REITs), the lack of diversification that real estate causes by the nature of the large investment, the effects of property taxes and closing costs, long term maintenance costs, the effects of property management costs, anchoring and lack of mobility that owning a home causes.

Duke the lost engine

A lot of younger people already heavily invested in housing though, via our parents and even grandparents. Arguably even some people who don’t own a house could be over-invested relative to other assets

john

It might be nice to have a date associated with "present". Are we talking March 2019 or a few years ago?

The other thing to note is probably that post 2008 crash there has already been a lot of increased investment in housing and real estate.

As noted above, a lot of people are already over invested, from a diversification perspective, in housing/real estate (one can add in the industry they work in as well -- thoughts for those employee stock purchase plans even with the discounted price).

Still, the point that it is an area all investors should be aware of and most using is valid.

Simian

The Herengracht Index, which uses a fairly consistent-quality cohort of real estate going back several centuries, suggests that the real return of real estate over the very long horizon is MUCH more modest and that more recent studies are driven primarily by the post-WW2 period.

Any study of asset class returns or asset allocation naturally has low statistical significance over a period of decades, given the small number of asset classes - and of economic cycles over such a period - and likely necessitates centuries to really draw strong conclusions.

Bring on the old data!

water boy

"That is a puzzle, and maybe it means risk is a smaller factor shaping portfolio decisions than we used to think. For instance, there may be reasons of psychology and upbringing, or market segmentation, that many people do not deploy their money more aggressively." Does this represent an equilibrium? If more people deployed their capital more aggressively would real returns decrease?